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  • Writer's pictureMartin Kollmorgen

Pounding the table on REITs: Dumb or Dumber? +1.87% in May, +1.01% YTD

Updated: 2 days ago

"We got no food, we got no jobs, our pets heads are falling off!” – Lloyd Christmas: Dumb and Dumber

  • PERFORMANCE: Serenity Alternative Investments Fund I returned +1.87% net of fees in May vs the REIT index at +4.67%. In 2024, the fund has returned +1.01% vs -3.03% for REITs.

  • DUMB? REITs have under-performed since 2021…are we buying a broken asset class?

  • TOTALLY REDEEM YOURSELF: Accelerating fundamentals are the key to future REIT momentum.

  • AN 84 SHEEPDOG: How do we reach the REIT promised land? Riding a tried-and-true REIT vehicle.

Declining earnings growth.

Rising interest rates.

Under-performance relative to the S&P 500.

Since 2022 REITs have been hit by a trifecta of investing haymakers. Asset allocators have run for the exits. REITs are now a four-letter word, and very few investors want to buy into this asset class for fear of looking…wait for it…dumb.

But just when you think REIT investors could not get any dumber…

You guessed it…they totally redeem themselves!

All kidding aside, REITs have certainly earned their place in the doghouse over the past 24 months. But as experienced investors know, returns are often greatest where capital is the most scarce (that’s a Rich Bernstein axiom).

Said another way? REITs are often the most attractive precisely when nobody is looking.

And in June of 2024…there are very few eyeballs on this niche sector of the stock market. People seem to have forgotten that it contains some of the most irreplaceable commercial real estate portfolios on the planet.

So, is Serenity dumb for making a bet on the comeback of an asset class that has averaged +9.6% annualized returns over the last 30 years? An asset class with the highest quality balance sheets, best diversified portfolios, and most sophisticated management teams in commercial real estate?

It may sound silly, but I’m betting on redemption for REITs. One year from now growth is likely to be higher, REIT portfolios are likely to be larger, and interest rates could very easily be much more favorable. In that environment is owning REITs dumb? Quite the opposite…

PERFORMANCE: +1.87% in May vs REITs +4.67%

Serenity Alternative Investments Fund I returned +1.87% in May net of fees and expenses versus the MSCI US REIT Index which returned +4.67%. Year to date Serenity Alts Fund I has returned +1.01% vs the REIT index at -3.03%. On a trailing 3-year basis, Serenity Alts Fund I has returned +2.8% annually net of fees versus the REIT index at +0.1%. Over the past 5 years Serenity Alternatives Fund I has returned +11.7% annually net of fees and expenses, versus +3.6% for the REIT index.

The most profitable position in the fund in May was American Tower (AMT), a long position which returned +14.09% during the month. May saw a reversal in recent interest rate headwinds that have plagued duration sensitive REITs. As a low volatility growth company, AMT (with over 200,000 cell towers) has become an increasingly defensive, high duration exposure within the REIT sector. We like AMT for its incredible cash flow generation, attractive valuation, and stealth Data Center exposure. If fundamentals in the tower industry can improve after a 2–3-year lull, AMT could re-rate significantly higher. In the meantime, the company will continue to compound cash flow and grow its dividend.  

The least profitable position for the fund in May was Medical Properties Trust (MPW), a short position which returned +16.52% during the month. As a highly shorted stock, MPW benefited from the return of Gamestop mania last month, as a huge swath of highly shorted stocks shot higher in May. Not much has fundamentally changed for MPW…their largest tenant continues to go through bankruptcy proceedings, they have over $1 billion in debt maturities in early 2025, and their dividend is woefully un-covered. While this position requires a high degree of risk management, we have shorted MPW since it was an $18 stock (closed at $4.93 today), and our current bet size is modest.

DUMB! Examining the idea that buying REITs is NOT smart.

An informative exercise in investing is to take the other side of your current position and write down the evidence someone would use to bet against you. If the contra case is compelling when written down, you have may have made a mistake, and need to re-address the portfolio’s positioning.

At this juncture, many REIT investors can recite the REIT bear case cold…because we hear it from asset allocators all the time. There are two main arguments that investors currently use to justify ignoring (or even shorting) REITs. Let’s hit each one by one.

  1. Higher for Longer – This is the overwhelming favorite for REIT bears. It’s a simple, straightforward argument. Interest rates have increased, which has led to REIT under-performance. If they stay high, there is no reason to buy REITs.

There are two key problems with this argument. First, REIT prices already reflect a higher interest rate environment. Meaning that unless interest rates go up from here, REIT valuations do not have meaningful downside. If interest rates move sideways, or move lower, REITs will thrive. Also, current trends are moving in the opposite direction (of the bear case). Inflation continues to moderate on a year over year basis, and credit spreads have compressed meaningfully over the past six months.

The second key problem with the higher for longer argument is that it ignores REIT’s lower cost of capital relative to private peers. This is something that was discussed widely at this year’s NAREIT REIT Week conference in early June. For the first time in this cycle, REITs have begun to command a significant advantage in the debt markets relative to the rest of the CRE industry. This makes sense, as publicly traded REITs tend to have less leverage and higher quality, better diversified portfolios, than their counterparts in the private equity CRE space.

This cost of capital advantage could prove meaningful going into 2025, as it provides another growth lever for REITs, while other CRE firms are shrinking just to survive. For anyone forced to sell assets to meet redemptions or to alleviate a cash crunch, the REITs can effectively dictate terms as some of the only well capitalized buyers in the market.

Take Public Storage’s (PSA) recent acquisition of Simply Self-Storage from Blackstone’s private BREIT as a perfect example. To meet redemption requests, Blackstone was forced to sell $2.2 billion worth of self-storage assets near the end of 2023. And who did they go to? One of the best capitalized companies on the planet in Public Storage, who by all accounts was thrilled to be handed a high-quality storage portfolio at an extremely attractive cap rate.

Commercial real estate pain is beginning to turn into REITs gain. In this regard, higher for longer is, in fact, a benefit to REITs relative to their competition.

2. REITs have under-performed – Many investors view REITs as defensive investments, and their failure to protect portfolios in 2022 has left a sour taste in the mouth of asset allocators. I consistently hear some version of the following argument. “It seems like REITs have all the downside of the stock market but not as much upside. Why should I own something that consistently under-performs?”

This one is easier to debunk because it is pure recency bias. Going into 2022, REITs were THE leading asset class of the prior 30 YEARS (+11.3%/year 1992-2022). They had outperformed large cap stocks (+10.6%), emerging market equities (+7.6%), developed international equities (+6.1%), investment grade bonds (+5.2%), and high yield bonds (+7.8%). While REITs certainly underperformed the magnificent 7 stocks in 2023 (unfortunately REITs are not AI pioneers), they outperformed the S&P 500 by +14% in 2021. From 2010 – 2015 they outperformed the S&P 500 in 5/6 years. The sector consistently bounces back from periods of under-performance.

The chart on the next page illustrates this point. Using 10-year trailing returns and going back to 1981, REITs and large cap stocks periodically outperform each other. While large caps have an edge during the current 10-year trailing window (+12% vs +8% for REITs), it was not long ago that REITs had a similar advantage (at the end of 2012 REITs had returned +11.8% annually for 10 years while the S&P trailed at +7.1%).

The point here is that there is little evidence that REIT underperformance is persistent. Do REITs have equity-like volatility? Yes. But they also have equity-like returns, with cash flowing portfolios that are much higher quality than private peers. REIT volatility in fact likely overstates the cash-flow risk of most REIT portfolios.

To summarize, REITs underperformed large cap stocks in 2022 and 2023 as interest rates rose at the fastest pace since the 1970s. This has led many asset allocators to conclude that amidst higher interest rates, there is no reason to own REITs. Theory and history, however, would suggest otherwise, as REITs traditionally rebound from periods of underperformance, and more importantly, fundamentals may be finally turning in the right direction...

THE ROAD TO REDEMPTION: How REITs right the ship.

The bear case for REITs then rests on the possibility that interest rates spike and REIT growth continues to languish. Essentially a return to a 2022, 2023 type of economic environment. Unfortunately for the Bears there is a mounting pile of evidence that points towards a very different picture later in 2024 and 2025.

The key difference that non-REIT focused investors tend to miss is something we have been writing about for months/years. The slope of growth.

Growth slowing (in my humble opinion) was the key culprit for REIT underperformance over the past 2 years. We wrote about it before it happened, as it was happening, and are now on the precipice of a significant turn in this two-year-old narrative. Put simply, REIT growth has re-set much lower, has easier comps going forward, and should see tailwinds begin to materialize as early as late 2024.

Again, this is what REIT bears and skeptics miss, and it is the key to the whole equation. When growth accelerates, REITs perform extremely well. When it decelerates…they underperform. It’s just that simple.

What are the key catalysts needed for REIT growth to turn around? Let’s make a list.

  1. Lower Supply – 2024 will set records for the number of Apartments and Warehouses constructed over the past 50 years. We are past the peak, however, and the amount of supply being introduced will begin to fade rapidly over the next 6 months. In 2025 this becomes a significant tailwind for a large swath of the REIT industry. Put simply, more construction = bad for REITs, less construction = good. Looking forward the answer is clear…less construction.

  2. Easier Comps – In 2022 REITs had to comp against the best organic growth year in REIT history (2021). In 2023, REITs had to comp against the second-best organic growth year in REIT history (2022). In 2024 REITs had to…you get the picture. In 2025, however, REITs finally get a favorable comp. For the first time since 2021. And remember what happened in 2021? <pssst REITs were up +41%>

  3. Open Capital Markets – The capital markets have improved significantly for REITs over the past 6 months, and the companies are beginning to reap the benefits. We already discussed the Blackstone/PSA deal that occurred in late 2023, and more and more REITs are licking their chops as the deal pipeline heats up. After 18 months of very little activity on the acquisitions front…REITs could re-enter the market as buyers in size. This would act as an additional earnings growth lever that has been absent for almost 2 years.

Part of the reason I continue to pound the table on REITs in 2024 is that these three factors are not simply fading headwinds. They are in fact 180 degree turns. In 2025 potentially all three of the above factors will be REIT tailwinds. And the virtuous cycle this engenders can be POWERFUL.

It looks like this. REIT fundamentals accelerate off a low base, REIT stock prices go up. REITs use their newly advantageous cost of capital to accelerate acquisition activity, pushing earnings estimates higher. REIT stock prices go up more. Supply headwinds continue to fade, pushing organic growth even higher. REIT stock prices go up more. REITs issue equity at premiums to NAV, pushing their NAV’s/share higher, then invest accretively, pushing NAV’s/share higher again.

This is not a pipe dream. This happened from 2010-2015, a period over which REITs returned +14.5% per year. Remember, John Gray of Blackstone compared the current environment to 2010 in his firm’s first quarter earnings call.

When all is said and done, Serenity’s efforts are focused on uncovering the most probable path for REIT growth going forward. I cannot predict the movement of interest rates, but I can measure the slope of growth and gauge the key drivers thereof. The picture right now looks much more favorable going forward than any time since late 2020.

84 SHEEPDOG: A REIT example we will ride to the promised land…

If the destination for REITs is much sunnier in 2025, the next logical question is which companies will get us to our destination?

We’ve already mentioned one of Serenity’s favorite current long ideas. The fortress balance sheet titan of the Self-Storage industry Public Storage (PSA).

PSA is a good microcosm for much of the REIT industry, particularly the cyclical REITs which Serenity’s portfolio is currently tilted towards. Over the past 2 years, PSA’s same-store revenue growth has fallen methodically from +15.7% to +0.0% in the first quarter of 2024. Going back to 2004 this value averages +4.2%. We have mostly avoided self-storage on the long side since 2021 for this very reason. Growth has consistently decelerated every quarter for the better part of 2 years.

This has driven PSA’s valuation to levels not seen since 2010. Take a minute to process that previous sentence. The last time Public Storage was this cheap was immediately following the great financial crisis, a period in which anything commercial real estate related was avoided like the plague.

Now a few historical stats. Over the past 10 years PSA has grown their AFFO/Share (cash flow) by +7.61% annually. They have grown their NAV/Share by +7.8% on an annualized basis. From 2010 – 2022 the company returned +17.4% on an annual basis. As mentioned before, PSA on average produces +4.2% SS revenue growth, but is currently growing at +0%.

In 2025, PSA will have extremely easy growth comps in the same-store pool, much less supply to contend with (self-storage supply is drying up like other property sectors), and a potentially much more active acquisition pipeline.

To be honest, I do not know what the bear case is for PSA here. That somehow growth goes to -2% for Storage, a metric the industry has not seen outside of recessions? A recession would certainly impact the portfolio, but would also very likely lead to much lower interest rates, so even that outcome has a silver lining for PSA.

Here is what I see happening. Over the next 4-5 quarters, PSA slowly regains pricing power, beats and raises their guidance, and by mid-2025 is headed to +3% same-store revenue growth. I believe this would drive the company’s valuation back towards its historical median of +21x AFFO. Applying that multiple to consensus 2025 AFFO/Share would yield a price target of $337, roughly +20% higher than today’s stock price.

That’s a very conservative way to get to +20% YoY returns, which may only be the tip of the iceberg. Remember following the GFC PSA posted +17% returns for OVER 10 YEARS.

Long story short, PSA has a fortress balance sheet, an excellent management team, a history of above average cash flow and NAV growth, trades at an extremely discounted valuation and has numerous tailwinds headed into 2025.

Still think buying REITs is a dumb idea?


Over more than 8 years of running Serenity, I have made plenty of well…dumb decisions. Almost none of them have come when buying REITs at highly discounted prices when fundamentals are inflecting positively. We did this in 2020 and the fund returned +46% in 2021. We made a somewhat similar call at the end of 2018 and in 2019 the fund returned +32.4%.

While the REIT promised land may seem far off, 2025 is barely more than 6 months away.

Imagine someplace warm, where multi-family earnings flow like wine, and the asset allocators instinctively flock like the salmon of Capistrano.

REITs are not on investor radars in 2024. In 2025, it may be hard to keep them off.

Samsonite! I was way off,

Martin D Kollmorgen, CFA CEO and Chief Investment Officer Serenity Alternative Investments Office: (630) 730-5745

*All charts generated using data from Bloomberg LP, S&P Global, and Serenity Alternative Investments

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